Question

MARS, Inc. (D)¹

In January 2009, Tom Sosa, the purchasing manager, received a telephone call from their Columbus, Indiana, diesel engine supplier informing him that effective June they were no longer producing the D-342 diesel engines at the Columbus plant. The D-342 engine sales were decreasing and would no longer be in their product line. Tom was in shock. He was now forced to deal with the sole supplier of the D-342 located in Portland, Oregon. The most recent price schedule submitted by the Oregon engine supplier is given below:

Units per Order	Unit Price
Less than or equal to 100	$ 4,800
Between 100 and 200	4,700
Greater than 200	4,550

The prices had been basically the same as the Columbus supplier except that they are F.O.B. Portland. The traffic department informed Tom that the transportation cost per hundredweight is $10 for carload lots of 50,000 pounds. The less than carload rate is $15 per hundredweight. The replenishment cycle normally takes one week.

BACKGROUND

Tom Sosa, the supply manager for MARS, Inc. was contemplating several significant changes in the D-342 diesel engine market. Mr. Sosa was concerned because in its production of the 98-D loader, MARS used 10 diesel engines each working day of the month. (MARS operated on a 20-day-per-month schedule.) Each engine weighs 500 pounds. Engine orders are currently placed every Monday morning. For the past 10 years, the D-342 engines had been produced in only two locations in the United States, one in Columbus, Indiana, and the other in Portland, Oregon. Mr. Sosa felt fortunate that the Columbus producer was located approximately 30 miles from his facility. The Columbus supplier offered just-in-time delivery service at no charge to MARS.

MARS implemented lean manufacturing in 2002. The kanban-controlled JIT production system was implemented based on the premise of minimizing work-in-process inventories (waste) by reducing lot sizes in order to increase production efficiency and product quality.

ACTION TAKEN BY TOM

Mr. Sosa compiled cost and warehouse capacity data on the D-342 engine from the accounting department. See Table C17.1.

Mr. Sosa wonders what effects these new developments will have on his cost structure.

Assignment Questions

  1.  What were MARS’s total costs per year prior to the new price structure when the diesel engine price was $4,800? Was MARS using the EOQ method?

TABLE C17.1
Cost and Warehouse Capacity

Cost of unloading engines into warehouse	$0.25 (per 100/wt)
Order processing cost per requisition	$100
Warehouse capacity	200 units
Outside warehouse costs	$39 per year per unit*
Expediting cost per requisition	$50
Inventory carrying cost	38%

*There is existing space in the warehouse for 200 units. Additional space must be leased for a year. If an order is more than 200 units, part of the order must be stored in leased space.

  2.  With volume discounts and warehouse constraints, what is the best ordering quantity?

  3.  With purchase discounts and different rates, how are costs and EOQs affected?

  4.  How will these changes impact the lean manufacturing philosophy at MARS?

  5.  Determine the cost impact of using the Portland supplier. How will the change in supplier for the D-342 diesel engine affect sales for the 98-D loader?

Answer 1

Requirement of engines = 10 diesel engines each working day of the month
Days per month = 20 days
Total requirement in a month= 10 diesel engine per working day * 20 working day
= 200 diesel engine per month

Weeks in month = 4 weeks ( assumption)
hence requisition in a month= 4(each on monday morning)
Engines ordered in a monday= 200 engines/4 weeks
= 50 engines

(1)

Total cost per year prior to the new price structure when the diesel engine price was $4800:-
Total engines required= 200 diesel engine per month * 12 months
= 2400 engines
Cost of engines= 2400 engines* $4800 = $11520000 -(A)

Cost of unloading engines into warehouse= 0.25 per hundered weight* total engines required in a year* 500 pounds
=0.25*2400 engines* 500 pounds
=$300000 -(B)

Order processing cost per requisition= $100
Total requision= Requisition in a month * 12 month
= 4 * 12 = 48 requisitions
So Total order processing cost= 48 requisitions * $100
= $4800 -(C)

outside warehousing cost= Nil (since each order unit is 50 engines. its less than capacity of warehouse)

Expediting cost per requisition= $50
Total requision= 48 requisitions
Total expediting cost= 48 requisitions * $50
= $2400 -(D)

Inventory carrying cost = 38%
Average annual value of inventory= 50 engines* $4800
= $240000
Average inventory = 50 engines((op. inv+cl.inv)/2)
Inventory carrying cost= $240000*38%
= 91200 -(E)
Total cost= A+B+C+D+E
= 11520000+300000+4800+2400+91200
= $11918400
EOQ

The formula for EOQ is:

Q=

where

Q= EOQ units

D= Demand in units (Typically on an annual basis) 2400 unts

S= Order cost (per purchase order) $100

H= Holding cost(per unit, per year) = 4800*38% =1824

Q= (2*2400*100)/ 1824

= 480000/1824

=263.15

=16.22 units

= 17 units (rounded)

Engines ordered in a monday= 200 engines/4 weeks
= 50 engines

Since EOQ= 17 units, MARS was not using EOQ method.

(2)

Unit	Total cost	Transporation cost	Cost of unloading	Order processing	O/s warehousing	Expediting cost	Inv. Carrying cost	Total cost
50	11520000	3750	62.5	4800	0	2400	4377600	15908612.5
100	11280000	5000	125	2400	0	1200	4286400	15575125
150	11280000	7500	187.5	1600	0	800	4286400	15576487.5
200	11280000	10000	250	1200	0	600	4286400	15578450
250	10920000	12500	312.5	1000	1950	500	4149600	15085862.5
300	10920000	15000	375	800	3900	400	4149600	15090075

Cost is lowest for the price of $4550

Hence most preferable ordering quatity will be more than 200.

Preferably 250 units per order.

(3)

With purchase discounts, it will be better to order more quanties in an order. It is better for transportation cost also.

but this will increase the inv. holding cost. and afffect EOQ.

EOQ method is not preferable in this case die to high discounts in purchase quantities

(4)

Lean philosophy focus on reducing waste.like

1. Over processing
2. Transportation
3. Motion
4. Inventory
5. Waiting
6. Scrap and defects

the company philosophy might get affect since the firm has to order large quantities due to purchase discounts and trans. cost. Hence it may resukt in inc cost and over processing etc. and incur inv. holding cost.

However this may compensate by purchase discounts.

(5)

Cost impact:

Following points would have impact on the cost

Inventory holding cost: Since Portland supplier would be able to supply engines with average 1 week lead time, MARS will have to shift from JIT model to conventional model. Company consumes 200 engines per month. To prevent disruption in production due to 1 week lead time and possible unexpected delays in supply, MARS would have to place order for 200 engines at once. this quantity would help reduce cost per engine and transport cost. But MARS will have to bear inventory carrying cost for 200 units per month as well as satefy stock which would be stocked in leased warehouse. hence total inventory holding cost = inventory carrying cost for 200 engines + $39 * safety stock units

Transportation cost: Since Portland supplier would not provide free delivery (like Columbus supplier), transportation charge would add up to the cost. weight of 200 engines = 200*500 pound = 100,000 pounds. Transportation charge of $10 per 100 pounds would apply. tranportation cost = (100,000/100)*$10 = $ 10,000

Free on Board: MARS would bear the responsibility of any damage to the engines once they are shipped from Portland.